While investors are largely prepared for a possible Fed lift off on US benchmark interests, the possible de-linking of the Chinese yuan with the US dollar may be a bigger concern for global markets, says Neelkanth Mishra, managing director, Equity Research, with Credit Suisse Securities.
He said that the bout of FII outflows witnessed by India may continue in 2016 amidst frequent selling by investors from commodity dependent countries that witness a stress on their current account surpluses. In a press briefing sharing 2016 outlook, Mishra said that teh banking sector at large will be forced to recognise bad loans in the next 12-18 months and the industry is likely to bring more pain to the markets.
Impact of a Fed rate hike
A Federal Reserve lift-off may not create much near-term volatility. Because most investors are expecting it and so it is safe to assume that they are positioned for it. But a more interesting thing that could happen is the Fed’s raising of rates will further the de-linking of the Chinese yuan and the US dollar. There are clear signs that China wants to move towards a wider basket of currency and the ed rate hike will accelerate the process. So the removal of this certainty about the linkage between two of the biggest economies may de-stabilise the markets as investors will struggle to understand what it means in the new world order.
FII flows in 2016
Because of the global commodity price declines, the trade balance has shifted. The countries that had substantial current account surpluses, including exporters of commodities like oil, iron ore or even some Scandinavian are looking at a reduction in their current account surpluses. At the current price of oil, West Asian economies are struggling to manage their budgets and in every two to three months, some of the biggest funds witness redemption requests from these investors. This is not entirely con-incident to the decline in oil prices as the redemption may lag the fall.
Second, countries like South Africa, Brasil and Russia are witnessing widening of the current account deficits. The only way they can have sable CAD is by destroying domestic demand which in turn leads to their economies slowing dramatically. So as an EM fund, even if you don’t receive a redemption request, you would want to get out of these markets. Even political unrest adds to exits. Because the large part of foreign money to India has come through such funds, as EM funds see sell-off India also faces waves of selling. This dynamic will persist through 2016 as well.
India as an asset class is emerging as India-centric funds are seeing higher inflows. They are not yet large enough to offset the reversal of the prime trend of the impact of EM outflow.
Outlook & recommendation
Credit Suisse is advising investors to favour stocks of companies with local exposure, as the recovery is likely to strengthen in the new year. The pickup in government spending on roads and railways should translate into more downstream activity in the coming months boosting demand for labour, construction equipment as well as cement. In particular, the first 4-5 months of the calendar year should benefit from beneficial base effects. With 2014-16 earnings growth forecast of 13% CAGR, India ranks among the best markets globally. We believe the with MSCI India’s P/E premium to MSCI World (+11%) near ten-year lows, this is supportive of a 13-15% out-performance of the broader indices.
Banks and NPAs
Real credit growth adjusted for deflation (WPI) is far from weak. As the WPI starts to tend towards zero and towards positive territory next year, the nominal credit growth may pick up from 8%-9%. Even the split in credit growth shows that, personal credit and NBFC AUMs have been doing well. The problem of course is NPAs and we have been highlighting the under-reported nature.
There is a large gap between reported reported gross NPAs (4.8%) and what we think is the extent of problem loans (17.5%) and I don’t think till this gap is breached this sector is worth investing in. In the next 12 to 18 months, the banks will be forced to recognise some of these bad loans.